Yield Curve Flattening?
The Yield curve is flattening, so they say. But in reality, it isn’t as flat as you would think. Going back to 1976, the 10-2yr yield has averaged 0.9696%, with a standard deviation of 0.93%. Or more easily put, the 10-2 year spread, has a one standard deviation move with the range of 0.03% and 1.89%, the spread currently: 0.83%. Certainly, much closer to the average than the low end of the range. The 10-2 minus when negative can signal a recession is on the way. At present, the curve is a long way from signaling recession. As the chart below shows, again very far from an inverted yield curve, and very far from recession.
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One can see how the economy has been trending nicely higher since bottoming in the second quarter of 2016. GDPNow, which is calculated by the Atlanta Fed is tracking at 2.2 percent for the third quarter. Which given all the economic upheaval in places like Texas and Florida, doesn’t seem all that bad.
Fed Lifting Rates
Inflation remains, low and that is the primary reason for the flattening curve, while the Fed seems intent on raising rates in 2017. Because the Fed is lifting the front-end of the curve, and low inflation rates are keeping the long-end down, it is causing the flattening. The flattening happening now is not because the long-end is coming down to the short end of the curve. It is happening because the short-end is rising to the long-end.
Too Much Tightening
The chart below shows how in 2001, the fed cut rates, bringing the short-end down, causing the spread to widen. The Fed began to raise rates around 2004 and ended lifting too much, which was the spark that triggered and brought on the great recession of 2008. The same thing occurred in the late 1990’s. The chart clearly shows the downward bias on interest rates have had over the long-term.
Since peaking in the early 1980’s inflation has been falling as noted by CPI and PPI.
Continue to expect inflation to remain low, and rates to remain low, it is a trend that is likely not changing anytime soon. The economy is doing just fine.
Disclaimer : Mott Capital Management, LLC is a registered investment adviser. Information presented is for educational purposes only and does not intend to make an offer or solicitation for the sale or purchase of any specific securities, investments, or investment strategies. Investments involve risk and unless otherwise stated, are not guaranteed. Be sure to first consult with a qualified financial adviser and/or tax professional before implementing any strategy discussed herein. Past performance is not indicative of future performance.
Article by Michael Kramer, Mott Capital Management